Price gains achieved by reinsurance underwriters are likely to prove generally more sustainable than those achieved by property and casualty (P&C) insurance carriers, but margin gains may prove lower due to the unique pressures reinsurers face, according to Morgan Stanley analysts.
Rates and pricing have been on the rise across P&C insurance and reinsurance lines of business, with the hardening first seen and perhaps most vigorously experienced in the US P&C space.
But Morgan Stanley’s equity analyst team believe that price gains will begin to wane or decelerate later this year for the P&C primary lines, while reinsurance price gains may prove more sustainable, as there are more fundamental reasons to keep them higher.
Not least among these is the lack of profitability among the reinsurance cohort over recent years, which as broker Willis Re recently explained means that returns on equity (ROE’s) remain below reinsurers cost-of-capital, in the main, even though underwriting results are improving.
The analysts expect that reinsurance price gains will prove more sustainable this time because of: 1) elevated catastrophe losses; (2) concerns related to casualty prior year reserves; (3) persistent higher levels of litigation (aka, “social inflation”); (4) Covid-19 pandemic related uncertainty; and (5) low investment yields.
The pandemic related uncertainty is expected to be more of an issue for reinsurers than for primary insurers, as reinsurance capital will remain exposed to longer-tailed potential effects of COVID, while there is still uncertainty over eventual reinsurance recoveries from business interruption.
However, while the analysts from Morgan Stanley expect to see more sustainability of pricing in the reinsurance sector, they say that margin gains for reinsurers are not expected to be as pronounced as the primary carriers will experience, with those five drivers among the reasons.
The analysts believe that those reinsurance firms that have progressively reduced their catastrophe exposures will be among those who benefit the most from the hardening pricing environment, which may also go some way to explain the increasing use of third-party reinsurance capital in the sector, as well as the increasing use of instruments such as catastrophe bonds.
Those two factors, using more managed third-party capital within reinsurance businesses, or leveraging the appetite of catastrophe bond investors as another way to effectively reduce catastrophe exposure, can achieve similar results to purely wriitng less cat risk.
Enabling reinsurers to put peak catastrophe exposed risks onto efficient capital, while also benefiting by being able to continue writing it, in some cases more of it.
We’ve been saying for a while now that the stage of the cycle we find ourselves at may make it increasingly conducive to bring even more third-party capital into reinsurance businesses at this time, as long as peak exposures are being well-managed and the alignment of interests remains strong.
Morgan Stanley’s analysts also see reinsurers as having better growth prospects than primary carriers, which again can be assisted by use of third-party capital and insurance-linked securities (ILS) structures.